Section 163(j) Rules on Related Party Interest Deductions Navigating - PowerPoint PPT Presentation

Presenting a live 110 ‐ minute teleconference with interactive Q&A Section 163(j) Rules on Related ‐ Party Interest Deductions Navigating the Earnings ‐ Stripping Regulations and Form 8926 Compliance WEDNESDAY, FEBRUARY 10 , 2011 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Mark Van Deusen Partner Hunton & Williams Richmond Va Mark Van Deusen, Partner, Hunton & Williams , Richmond, Va. Susan Conklin, International Tax Director, PricewaterhouseCoopers , Washington, D.C. For this program, attendees must listen to the audio over the telephone. Please refer to the instructions emailed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at1-800-926-7926 ext. 10 .

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S Sect. 163(j) Rules on Related ‐ Party t 6 (j) R l R l t d P t Interest Deductions Webinar Feb. 10, 2011 Marc Van Deusen, Hunton & Williams , Susan Conklin, PricewaterhouseCoopers , p mvandeusen@hunton.com susan.j.conklin@us.pwc.com

Today’s Program Review Of Material Terms Of 163(j) Regs Slide 6 – Slide 36 [Marc Van Deusen] Earnings Stripping: Compliance Issues Practical Scenarios Earnings Stripping: Compliance Issues, Practical Scenarios Slid 37 Slid 50 Slide 37 – Slide 50 [S usan Conklin]

Marc Van Deusen, Hunton & Williams REVIEW OF MATERIAL TERMS REVIEW OF MATERIAL TERMS OF SECT. 163(j) REGS

History, Purpose Of Sect. 163(j)  Sect. 163(j) was enacted by the Omnibus Budget Reconciliation Act of 1989. Reconciliation Act of 1989. – Intended to prevent erosion of the U.S. tax base by means of excessive deductions for interest paid by a taxable corporation to a tax-exempt (or partially tax- taxable corporation to a tax exempt (or partially tax exempt) related person   Proposed regulations were issued in 1991 but never finalized Proposed regulations were issued in 1991 but never finalized. 7

Sect.163(j): The Basics  Sect. 163(j) may limit deductions for any “ disqualified interest ” paid or accrued during the taxable year (e.g., interest paid to a “ related person ” that is not subject to U.S. tax). id t “ l t d ” th t i t bj t t U S t )  Amount disallowed will not exceed the “ excess interest expense. ” expense.  Sect. 163(j) applies only if the ratio of debt-to-equity exceeds 1.5 to 1 (the “ debt-to-equity safe harbor” ). ( ) q y 8

Key Definitions  “Disqualified interest”  “Related person”  “Excess interest expense”  Debt-to-equity safe harbor 9

“Disqualified Interest”  Any interest paid to a “ related person ” if no U.S. tax imposed on such interest  Any interest paid to a third party subject to a “ disqualified guarantee ” when no U.S. “gross basis tax” is imposed on such interest h i t t  Any interest paid by a “taxable REIT subsidiary” to a real estate investment trust (REIT) estate investment trust (REIT) 10

Definition Of “Related”  Any relationship described in sections 267(b) or 707(b)(1), including: – Two corporations that are members of the same “controlled group” (i e (1) parent with at least a 50% direct or indirect group (i.e., (1) parent with at least a 50% direct or indirect ownership by vote or value in a subsidiary or (2) five or fewer individuals own, directly or indirectly, more than 50% of two corporations by vote or value) – A corporation and a partnership, if the same persons own A corporation and a partnership if the same persons own more than 50% of the value of the outstanding stock of corporation and more than 50% of the capital or profits interests in the partnership – A partnership and a person owning more than 50% of the % f capital or profits interest in the partnership – Two partnerships in which the same persons own, directly or indirectly, more than 50% of the capital interests or y, 50% p s s profits interests 11

Related Party: Partnerships  Special rules for partnerships p p p – Interest accrued or paid to a partnership that is a “related party” is not “disqualified interest” if less than 10% of the profits and capital interest in the partnership are held by persons not subject to U.S. tax (except to the extent the t bj t t U S t ( t t th t t th interest allocable to a partner that is a “related party”). – When a partner benefits from a foreign tax treaty, the partner’s interest in the partnership is treated in part as partner s interest in the partnership is treated in part as tax-exempt interest. 12

Related Party: Interest Subject To Tax  Interest paid to a “related party” is disqualified only if the interest is not subject to U.S. tax. – Interest paid to a related foreign person will not be Interest paid to a related foreign person will not be disqualified interest if it is subject to full 30% withholding tax. 13

Interest Subject To Tax (Cont.)   Pass-through entities Pass-through entities – Determined at the partner level – Similar rules for pass-through entities other than partnerships partnerships • How does a corporation apply this to a publicly traded mutual fund (regulated investment company) or REIT? REIT? 14

Interest Subject To Tax (Cont.)  If a “related person” is a non-U.S. person entitled to treaty benefits, then only a portion of the interest is treated as not benefits, then only a portion of the interest is treated as not subject to tax.   Amount of interest that is treated as not subject to tax is based Amount of interest that is treated as not subject to tax is based on the proportion of: – (1) Rate of tax on the interest income, reduced by the treaty; and treaty; and – (2) Rate of tax on the income not reduced by the treaty 15

Example Corporation pays $90 of interest income to parent corporation resident in Australia. U.S.-Australia tax treaty reduces withholding on interest from 30% to 10%. Under Sect.163(j), $60 f i t $60 of interest paid by U.S. corporation is treated as not t id b U S ti i t t d t subject to U.S. tax. 16

Disqualified Guarantees  Interest paid to a third party will be “disqualified interest” if there is a “disqualified guarantee.”  Any “guarantee” by a “related person” that is made by: Any “guarantee” by a “related person” that is made by: – A tax-exempt, or – A foreign person if the interest is not subject to a U S gross basis if the interest is not subject to a U.S. gross basis tax – Exceptions • Interest on debt would have been subject to tax on a Interest on debt would have been subject to tax on a net basis if paid to the guarantor • Taxpayer owns a “controlling interest” (at least 80% by vote and value) in the guarantor 17

Definition Of “Guarantee”   Guarantee is defined broadly and includes any arrangement in Guarantee is defined broadly and includes any arrangement in which a person assures, on a conditional or unconditional basis, the payment of another’s obligation. – Commitment to make a capital contribution – Commitment to make a capital contribution – “Comfort letters,” even if not legally enforceable – Contingencies ignored 18

What Is “Excess Interest Expense”?  The excess of: – Corporation’s “ net interest expense ” over – The sum of (a) 50% of the “ adjusted taxable income ” of the corporation and (b) any “ excess limitation” carryforward 19

What Is “Net Interest Expense”? (Cont.)   Excess of interest paid or accrued over the amount of interest Excess of interest paid or accrued over the amount of interest includable in gross income – Usual tax accrual rules apply, including market discount and bond premium and bond premium – Look-through rule for partnerships: Partners include distributive shares of income and expense 20

What Is “Adjusted Taxable Income”?   An approximation for cash flow An approximation for cash flow  Taxable income, without regard to: – Net interest expense – Net operating losses and net capital losses – Depreciation, depletion and amortization deductions 21